Why Does Capital Have More Bargaining Power Than Labour?

The debate over libertarianism and the workplace (if you can call it a ‘debate’, when libertarians make responses like this, here is a summary of what Cowen and Tabarrok are saying) seems like as good a time as any to post on the bargaining power relationship between labour and capital.

I have posted before about how the idea that wages are determined by productivity is indefensible; capital and labour only have productivity when combined, so it is impossible to separate their relative contributions, which are instead determined by bargaining power. As Daniel Kuehn also notes, a ‘job’ is generally what is bargained over, rather than specific aspects. So it would not be unreasonable to say that working conditions, hours and pay are generally all determined by bargaining power, though not separately. It is also not unreasonable to say that employers generally have the edge in this. But why?

The first reason, noted by Paul Rosenberg, is that labour requires wages to subsist every day, whereas those sitting on capital can produce for themselves. This means that labour’s situation is generally more urgent than capital’s. Now, libertarians might respond that people can save money, inherit money, and so forth. But this begs a lot of questions: what if you are born poor? Where do you get your savings from initially, if not wages?

Libertarians also might respond, as the BHL libertarians have, by advocating a universal income (something that strikes me as trying to make the world behave like an economics textbook, where workers can smoothly trade off leisure for work, from 0 hours to 24). This would indeed improve labour’s bargaining power. However, it is also the case that, even under this system, many workers would incur obligations such as debts, families, and of course social obligations, that require money. Whether these people ‘choose’ to do this is irrelevant: what we are asking is if, at the moment somebody tries to get a job, they have more bargaining power than their employer.

The second reason is that employers are fewer than employees, making the latter more readily substitutable, particularly in low skilled jobs. This starts from the obvious observation that not everyone can be a capitalist. Since wages tend to be consumed, but profits don’t, it is fair to say that an increase in the amount of capitalists over workers will reduce consumption and therefore available profits. This will result in capitalists going bankrupt. Obviously, if there are too few capitalists then opportunities will also open up, and we will go in the other direction.

It is reasonable to conclude that there is a rough ratio of capital to labour around which the economy oscillates, something similar to what Phillips was actually saying with his ‘curve.’ Capitalism generally finds it hard to deal with true full employment, as it diminishes the capital available for investment. This results in lay offs, and diminishing bargaining power for labour. Historically, capitalism appears to spend a lot more time in period of unemployment than periods of full employment.

There is the final point that under modern capitalism, labour is free to organise and create collective bargaining power. However, in the absence of legislation to assist this, unionisation falls into all the familiar problems with collective action, problems that capital doesn’t have: coordination, aligning different interests, the incentive for individual members to cheat. This is reflected by the fact that countries with strong unions generally have legislative support of those unions, too.

Obviously I’ve been assuming that neither capital nor labour ‘hijack’ the state to further their own interests (questions over whether capitalism is a system characterised by capital’s hijacking of the state aside), but I don’t think it’s necessary to invoke these to understand why labour often seems to be on the losing side of the bargain, particularly for low skilled workers.

Bringing it back to the debate over libertarianism and the workplace, it’s worth noting that ‘voluntary’ versus ‘coerced’ is not a binary distinction but a spectrum, with one end representing virtually no costs for choosing something different, whilst the other represents death/torture. In between you can have anything from walking down the road to another shop to social pressure to moving country – all are costs of not taking a particular choice, and hence reduce the ‘voluntariness’ of the decision itself. If employers generally have more bargaining power, this is a reflection that the costs of them choosing another employee (or no employee at all) are lower than the costs of the employee taking another job (or no job at all). This means the spectrum is tilted further away from ‘voluntary’ for the labourers, and the mere axiom that they have agreed to it so it’s OK will not suffice.

The key is substitutability. Can the worker find an alternative employer offering him/her a better deal in terms of wages/hours/conditions, can the employer find and alternative worker willing to produce the same results at lower overall cost? A “superstar” can dictate terms to his/her employer, a run-of-the-mill employee can try negotiating, a public sector union can “hold the country to ransom” (and help the Conservatives win the next election). However if there are 100 people applying for one job the employer can pick the one who provides most value in excess of cost (and would be stupid not to do so).
I think it is a mistake to discuss the current position assuming that organised labour has not hijacked the state for its own advantage as the astronomical number of job applicants per vacancy demonstrates that wage levels are significantly higher than “the clearing price for labour”.

This is true, although once the job is taken and the costs of quitting rise, I think even superstars will generally accept that you do what the boss says, though of course the boundaries are tighter.

Your second point is only true based on the assumption that unemployment is caused by high wages rather than a lack of demand. Even then, I wouldn’t say that shows the state has necessarily been ‘hijacked.’ I mean, right now the main macroeconomic control is manipulation of the base rate to increase/decrease unemployment, which is surely against workers rather than for them.

Look at the British textile industry since the introduction of the National Minimum Wage. Look at the differential between public sector and private sector wage rates under New Labour – public sector wage rates should be lower because of job security but they are now higher – massively higher for middle-aged women if you include the cost of their inflation-proofed pensions (the cost will be decreased a little under the Coalition proposals). Look at the millions of pounds that the government is paying to full-time union officials nominally employed by the public sector. Look at the way The Guardian was financed by directing all public sector middle-class job adverts to the labour-supporting left-wing broadsheet, and how it is losing tens of millions now that jobs are advertised on the internet. Look at the million or so self-employed people who are earning less than the NMW because there is demand for the work they do but not at that price. I could go on.
The use of BoE base rate and QE to try to increase employment by encouraging spending rather than saving is *undoubtedly* for workers and against pensioners and other savers which includes capitalists who are not employers. I cannot understand how you get to your conclusion.

Regarding #2, let’s be clear that you are talking about a subset of all labour. Certain workers do have bargaining power, specifically those with a rare and desired skill, trait, or particular shape of “human capital”.

I still think you need to answer why the average/total Cobb-Douglas estimates are 70% labour, 30% capital, i.e. the lion’s share of returns are observed to pay labour.

I was unaware of that, but it strikes me as odd. Profits are at a record high and wages have been steadily eroding for the last few decades. I wonder what it would look like with CEOs, celebrities etc. taken out.

Profits are high but so is cash holdings. If you watch the business news you won’t get the “grand economic” picture. For example I can think of some stories of companies being “afraid” of giving dividends (nice time for some video interviews discussing how ridiculous that is) because it signals a lack of growth capacity. Well the dividends ARE the ultimate point, aren’t they?

Anyway yes the capital/labour ratio as estimated by a Cobb-Douglas model varies across countries and some older data might be on Wikipedia. Brasil used to be quite high capital/labour ratio which correlated nicely with the vast inequality. No idea about comparison of 2010 to 2005 to 2000.

“Capitalism generally finds it hard to deal with true full employment, as it diminishes the capital available for investment.”

Not just that. As Kalecki pointed out in his famous essay, in a full-employment economy, the social prestige of the capitalists is threatened. Workers have an unacceptable level of power in setting their working conditions. This is why Kalecki predicted that rulers would not choose to implement full employment, despite having the tools to do so.

It is not looking like anything like an agreement or a change of tune will come of this debate. However, since the BHL folks like the idea of a guaranteed income, I wonder if perhaps we could all agree on a Citizens’ Dividend? The idea — pushed by followers of the early libertarian Henry George — is that the state has a stake in the extraction of its natural resources (oil and the like) and sends monthly or annual “dividend” checks to all its citizens, drawn from the profits. Milton Friedman advocated for this to be implemented in Iraq, and it is presently practiced in the state of Alaska. In fact, the biggest payout under that program was under governor Sarah Palin. Is this an idea that libertarians or other right-wingers might get behind?

Attlee’s government aimed for full employment but settled on an unemployment rate of 2% as being the nearest they thought was possible due to “frictional unemployment” while workers were changing jobs. The following Conservative government under Churchill and Eden reduced unemployment to less than 2% (and this was using a definition that included those among the long-term sick and disabled who were unemployed). The social prestige of capitalists was far higher than it is today with unemployment (on a comparable basis) in excess of 10%. Maybe you need to unlearn whatever Kalecki mistaught you?
Alaska is copying Kuwait: I think I can safely say that some right-wingers have been behind this for a long time. Tony Barber planned a “negative income tax” in the early 70s but this was killed off by the Wilson government because it was too good an idea and Tony Barber, whom they hated, would have got the credit for an idea thought up by an adviser who used to work for the Inland Revenue and actually understood taxation.

I’m not sure how we’d measure ‘social prestige’ to be honest but John may well be right that under a more prosperous system, capitalists are generally well regarded. However, it might also be true that under full employment, capitalists make more, even though policies used to aim at that are generally against the will of capitalists.

I have long considered the possibility that capitalists are too short termist and fail to see that with a few restraints, they will actually make more money and be more highly regarded.

“However, it might also be true that under full employment, capitalists make more, even though policies used to aim at that are generally against the will of capitalists.”
NO. Capitalists want policies that indirectly lead to full employment because a stable economy growing at something slightly greater than the weighted average productivity improvement in manufacturing and services maximises the difference between the return on capital employed and the risk-weighted cost of capital since both the acceptable level of gearing and the cost of borrowing are risk-related. What the intelligent capitalist does not want is “make-work” schemes to create *apparent* full employment.

“Social prestige” was a bad way to put it. The point is that at full employment, workers have an uncomfortable degree of leverage. The postwar era of full employment that you cite was highly unusual, as this great post from Chris Dillow (courtesy of our host) shows: http://stumblingandmumbling.typepad.com/stumbling_and_mumbling/2012/07/unemployment-a-brief-history.html. And we know the way that story ended: the postwar arrangement was abandoned around 1980, replaced by inflation targeting and the “natural rate” hypothesis. I’d say Kalecki’s point holds up quite well.

@ Will
Do you mean “great” in a sarcastic sense?
The “post-war consensus” involved throwing bricks through windows displaying a Conservative party poster, successive nationalisation and de-nationalisation of steel; it was abandoned in 1974.
Please, just for once, look at the data: (i) unemployment was lower under the Conservatives (ii) leverage applies when the union can blackmail the employer or government – Iain MacLeod (a left-wing Conservative) called the union’s bluff when it tried a London Transport strike during full employment but ASLEF has repeatedly blackmailed British Rail when unemployment as higher. That has nothing to do with the level of unemployment in the economy as a whole. Bob Diamond was able to demand offensive amounts of money from Barclays because they thought he had leverage despite the high level of unemployment among investment bankers in recent years.

In a competitive model where one assumes that “neither capital nor labor ‘hijack’ the state to further their own interests” I think it is pretty easy to demonstrate that wage rates will be determined by the supply of “entrepreneurship” in the economy on one hand and the supply of labor on the other. There will also be a high level of correlation between productivity and individual wage rate and this will emerge without the need to for businesses to use marginalist calculations.

Assume a self-selected group of entrepreneur who compete to borrow funds with which to hire workers with the aim of producing goods that will be sold for a profit at some time in the future. Basic economics will lead to the conclusion that in this situation there will be a tendency for a single rate of profit to emerge in the economy based on the subjective desire for profit on the one side and the supply curve for labor on the other. If new entrepreneurs enter the market prepared to accept a lower rate of profit then the rate of profit will fall and the increased competition for labor will cause the wage rate to rise. If entrepreneurs drop out then the rate of profit will increase and the wage rate fall.

The thing that will stop a uniform rate of profit emerging will be different levels of entrepreneurial ability, which will allow successful business to exceed the average rate of profit and bad one to fall short. The ability to exceed will have many attributes but one of the key ones will be ability the to hire workers who can add more value to the business than they cost in wages (and that the value they add is more than the industry average). Business don’t have to calculate everything at the margin but those that get this right will tend to succeed more often than those that get it wrong. Thus a tendency will emerge for a high correlation to develop between productivity and wage rates.

Thus: The overall supply of labor is based on the subjective valuation of potential workers, the demand for labor on the subjective valuations of potential entrepreneurs with some individuals being in both groups. However behind these aggregate supply and demand curves there will be a strong tendency for the individual wage rate to be correlated to productivity even if this is not calculated at the margin for every wage earner.

I’ve read this a few times and I’m still not entirely sure how you come to your conclusion that there will be a correlation between productivity and wage rates.

My point is not that businesses do not make marginalist calculations explicitly, but that the idea of a marginal productivity for labour is itself bunk. While rising productivity may be associated with rising wage rates (this was the case from 1945-197x, but not from then on), that wages can correspond to a particular level of productivity for the labourers themselves does not make much sense, as they must be combined with capital and often with each other to produce the product.

The Darwinian approach to the as if-argument is all very MF53. That is, many employees will on average make decisions on the labour market as if they knew the productivity of the employers, because if they do not their businesses will not fail, is in my opinion not enough. Correlation (or prediction) is probably not enough if we want to understand how the labour market actually works and if we want to do something about it.

I would argue that firms are able to do a lot of suboptimal decisions for a long time without losing out. That is not to say that employers that are making stupider decisions than most do not tend to fail more often than others, but the distance between average employer behaviour and perfect rationality is so considerable that such models are not close enough for the world as it is.

Your are correct – the argument I gave above was very poorly stated. Apologies.

Let me try to explain this better and in the process to address the question of why this means that there will also be tendency for specific wage rates to reflect specific contributions to productivity.

I tried to show above how the average rate of entrepreneurial profit will emerge. In addition firms will strive to increase their own productivity level as this will increase their own rate of profit. Other firms will emulate the more productive techniques of the successful firms to drive up overall productivity. Thus competition between firms will lead to productivity increases over time.
These productivity increases would , if wage rates remain the same , lead to an increase in the rate of entrepreneurial profit which will attract new entrepreneurs and an expansion of business by existing entrepreneurs which will lead to wage rates increasing in line with productivity.

This explains (I hope) how real wages in general will increase to reflect productivity increases. How will this increase in wages be distributes between different groups of workers of different skills levels ? Different productive techniques will require different combinations of different kinds of labor. Some of this labor will be rarer in supply than others. Competition between firms for labor of the various skill levels plus attempts to optimize production techniques to make best use of the rarer skills will lead to specific wage rates reflecting specific contributions to productivity.
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The above is very simplified and leaves a whole bunch of details out – but overall I think it explains the general process.

OK, I get you. Of course it goes without saying that your analysis is almost entirely ‘frictionless’ (barriers to entry, perfect – or at least good – information, no brand loyalty). I think you are right within your own parameters, but something like good information is an example of a ‘domain’ assumption, where the conclusions only follow as long as it holds.

Thanks for your comments. I agree that once you start introducing noise into the system then some of the simple processes I describe get a lot more complex. The question I am trying to answer in my studies is whether the noise causes simple models to break down entirely or if they can still be used as a basis to understand the real world.

Could it be something as simple as Capital’s ability to buy a government that will sustain a chronic labour surplus for them? (By reducing government spending.) With a chronic labour surplus, market forces put downward pressure on wages. Business owners expect to maximize their profits in such an environment, since wages are one of their largest costs.

Consider how that changes if the government is used to spend increasing amounts of money on infrastructure, human capital, and other types of economic INVESTMENTS. If the government spends enough money on this increased production of real wealth, a chronic labour shortage could be created and maintained. More jobs would be available than there are people to hire, putting upward pressure on wages and benefits.

From the linked article:

If we focus our attention on what is happening to the Real Economy during a Labour Shortage, it soon becomes clear that we would be enjoying an outcome that is true economic perfection. All those who are able-bodied & able-minded would be producing something of value. In such an economy, the production & consumption of wealth would be optimized. Investment would be optimized. When production & consumption & investment are all at optimal levels, society gets to experience an ideal economic achievement.

If Labour were to ‘hijack’ the government in this way, it would not simply improve the welfare of wage earners at the expense of capital; it would actually also improve the welfare of the richest members of society, in REAL terms, though they be too blind to see it.

@: James Kroeger
Not in the UK. Unemployment is higher under Labour than Conservative governments, despite the tendency to increase government spending.
Capitalism desires an environment that generates steady real economic growth – full employment is a side-effect. Organised Labour, on the other hand, desires a maximisation of wages and minimisation of work done in unionised occupations, which reduces employment. The union representing BT engineers actually got a High court decision accepting their right to strike over the then government’s decision to let Cable & Wireless compete in the UK (although on the face of it that should have generated more jobs for the Telecommunication Workers Union members) – why? because the introduction of competition would lead to more work being done by fewer staff.

John I don’t want to get too much into partisan UK politics here, but it seems quite obvious that your first statement is wrong, at least for the last few decades. Unemployment was highest throughout the 80s and lowish under Labour until the crisis. It’s stagnated/gone up since the Tories came to power.

No, you might argue there are underlying mechanics that do not reflect each party, and I agree with that. But I think you are being misleading.

@ Unlearningecon
Starting in 1946 and working on a like-for-like basis (i.e. including those on incapacity benefit when comparing the noughties with the fifties, when those not in work were “unemployed”, not “incapacitated”) my statement is *not* wrong. It is one of the ironies of the British political landscape.
If you think unemployment under New Labour was lowish, you must be confusing reported unemployment, the “Claimant Count”, with actual unemployment that includes all those unemployed claiming Incapacity Benefit and those long-term unemployed who have given up applying for jobs. Most of the unemployed were in receipt of Incapacity Benefit rather than Jobseekers Allowance. Yes, there were too many people on IB under Thatcher’s government as well but peak unemployment under Brown was higher than under Thatcher despite directing tens of thousands of teenagers into so-called university courses.

Look I’m not going to get into a partisan row here, but bear in mind the post-WW2 BW system involved a large amount of capital controls and various interventions, no matter which government was in power. It was also characterised by higher employment.